Effective Cash Flow Management Strategies for Small Businesses
June 06, 2023 | 10 Min Read
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Understanding Cash Flow: A Cornerstone of Financial Success
The cash entering and exiting a business is referred to as cash flow. Cash inflows refer to the cash received from sales, investments, loans, or other sources, whereas outflows refer to cash paid for expenses, purchases of assets, repayment of loans, and so on. Categorizing all cash flows into the above two categories and tracking them is vital in determining the total cash position of the business at a specific period.
It is also essential to comprehend the difference between profit and positive cash flows. A profitable business does not necessarily mean that the business is simultaneously generating large stacks of cash. This can be better understood by using an example of a profitable sale where the customer delays the payment, leaving the business unable to translate the sale into immediate cash. Decisions made based on business profitability can result in a cash crunch, leading to the hindrance of daily operations, and resultantly limiting growth opportunities. It can also jeopardize the chances of the survival of the business.
Understanding this distinction is crucial as it serves as a cornerstone for financial success, as managers can now make informed decisions based on the cash available instead of solely relying on the profits generated, allowing the business to thrive for long-term success.
Analyzing Cash Flows: Insights from Cash Flow Statements
Cash flow analysis is a valuable tool that businesses use to make well-informed financial decisions.
Cash Flow Statements are one of the main financial statements in accounting. It outlines the cash inflows and outflows of a business during a specific period. They provide vital insights into the financial health of the business by summarizing the uses and sources of cash from operating, investing, and financing activities.
The Cash Flow Statement consists of the following categories:
Operating Activities: This category presents the cash-generating capacity of the business. It includes the cash received from sales to customers, payments made to suppliers, and employees, and expenses such as taxes, interests, and others.
Investing Activities: This section relates to the cash flows from the capital expenditures of the business. It includes cash received from the disposal of non-current assets and the cash outflows due to the acquisition of non-current assets such as property or equipment. These cash flows can significantly impact the liquidity of the business.
Financing Activities: This section outlines the cash flows from the financing of the business such as cash received from equity-holders or from lenders, dividends paid to shareholders, and cash paid for repayment of debt.
Analyzing Cash Flow Statements enables entrepreneurs to determine trends in cash flows, and the magnitude and details of the inflows and outflows, allowing businesses to proactively resolve liquidity issues, and make informed decisions regarding future capital expenditure, working capital, and the financing structure of the business. Businesses can make use of online accounting services such as Xero to streamline their bookkeeping, ensuring accurate financial statements are available in real-time.
Strategies to Optimize Cash Inflows and Manage Outflows
The following strategies can be used to Optimize cash inflows:
Incentivizing Early Payment: Businesses can offer customers incentives such as discounts for early payment. However, this is only a feasible option if there is a dire need for cash as it can negatively impact the bottom line.
Businesses should focus on providing accurate and timely invoices, clearly stating payment terms and due dates, with several online payment options to reduce the hassle for customers in making payments.
Efficient Accounts Receivables Management: It is vital for a company to regularly follow up on all receivables to ensure payment is processed on time and to monitor any overdue payments.
Management should clarify with all receivables the last payment dates, penalties, or interest charges on late payments. Regular monitoring of customers’ financial positions, as well as conducting stringent checks on the creditworthiness of new customers is essential in preventing any unanticipated losses due to the customer’s inability to pay.
Dispose of Unnecessary Assets: Any assets that are not in use should be disposed of to generate cash for the business. If some inventory is slow moving, discounts should be considered to sell it off quickly. Inventory management is essential to prevent unnecessary tying up of funds in inventory. It might be beneficial for the business to consider outsourcing its inventory through vendor-managed inventory or just-in-time inventory methods.
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To manage cash outflows, the following can be done:
Negotiating With Suppliers: Establishing strong relationships with suppliers is essential for managing cash outflows as management can negotiate extended credit terms, possibly lower prices, or even discounts for early payments. Significant discounts should be availed immediately to reduce costs, which can contain outflows, while simultaneously increasing profitability.
Controlling Costs: Businesses should analyze their cost structures, categorize them, and determine methods to reduce inefficiencies, leading to an overall reduction in cash outflows.
Existing contracts with suppliers and customers could also be renegotiated for more favorable pricing and payment terms for the business.
Similarly, energy-saving measures should be implemented while also considering more compact office spaces or a hybrid work model with employees working from home to save on rent and other utilities.
Further, the management should also consider delaying any unnecessary capital expenditure which could result in a drain on the cash flow.
Forecasting and Monitoring Cash Flows: Staying Ahead of the Curve
Forecasting and monitoring cash flows are vital measures that enable small and medium-sized businesses to achieve financial stability. With robust forecasting systems in place, businesses can anticipate and address potential cash shortfalls by securing additional financing in advance or cutting back on outflows temporarily to finance the gap.
Managers can also plan for expansions and other growth opportunities without jeopardizing daily operations.
Cash flows can be accurately projected using the following techniques:
Sales Forecasting: Forecasting sales is essential in determining the cash inflows of the business. Sales projections can be developed based on seasonal trends, estimates of customer demand, economic conditions, and historical data.
Expense Estimates: Like sales, expenses can also be projected. Expenses should first be categorized into fixed and variable expenses to produce accurate budgets for the cash outflows. Historical data, future contracts, and investment plans as well as any anticipated changes in costs of materials or other expenses should be considered to create a comprehensive view of the cash outflows.
Scenario Analysis: By considering multiple potential situations such as changes in economic conditions, shifts in customer demand, or even pandemic-like situations, businesses can identify potential risks and plan contingencies accordingly.
It is equally important for managers to monitor the cash flows on an ongoing basis to maintain financial stability. This can be done as follows:
Regular Review with Real-time Tracking: By regularly monitoring the actual inflows and outflows, businesses can identify any variances to the budgeted projections and analyze the reasons behind them.
By utilizing online accounting services, the company’s cash flows are available in real-time, allowing for timely and well-informed decisions. Financial statements can also be made regularly for a detailed view of the cash position of the firm.
Key Performance Indicators (KPIs): Establishing and Monitoring KPIs related to cash flow such as the cash conversion cycle is essential to assess the financial health of the business and identify areas for improvement.
Financing Cash Flow Shortages: Exploring Options and Solutions
Cash flow shortages can unexpectedly arise, causing problems for small businesses to meet financing requirements for operations and financial obligations. To bridge the gap, the following options can be considered:
Short-term Financing: Businesses can make use of business credit cards and lines of credit, which are predetermined credit limits that are repayable with interest. It provides quick access to cover short-term cash flow requirements.
Trade Credit: This is a situation where suppliers allow businesses access to materials with deferred payment terms, allowing temporary relief to the cash position of the business.
Invoice Factoring: A business can convert pending customer invoices into immediate cash through invoice factoring. The factoring company advances a percentage of the invoice to the business collects the payment from the customer and returns the balance amount to the business, after deducting their fees.
Invoice discounting is a similar process with the distinction of placing the pending invoices as collateral with a financial institution and receiving a loan in return, repayable after the customer completes their payments.
Small Business Loans and Grants: Businesses should also explore funding options and grants specifically designed to support small firms through financial institutions or government programs.
It is important to evaluate the terms, interest rates payable, repayment schedules, and other conditions when considering financing options. Seeking guidance from advisors or accountants can help in making informed decisions.
How Accountimize Can Help
Accountimize uses accounts payables and accounts receivables management software to optimize your cash flows. We help businesses receive cash faster and manage their outflows more efficiently by streamlining their accounts receivable collection and accounts payable payment process.
Get in touch with one of our CPAs and rest assured knowing your processes and reporting are overseen by accredited professionals.
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